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Operator
Good evening, everyone, and welcome to Shanda Interactive Entertainment Third Quarter 2007 Earnings Conference Call. The conference call will be recorded and available for replay in its entirety. A copy of Shanda’s third quarter 2007 results announcement can be found and downloaded from its corporate website at www.snda.com. At this time, all lines have been placed on listen-only mode and the floor will be open for questions following today's presentation.
I would now like to turn the call over to your host, Ms Maggie Zhou, Shanda's IR Manager. Please proceed, ma’am.
Maggie Yun Zhou - Investor Relations Manager
Thank you, operator. On behalf of Shanda I would like to welcome everyone to our third quarter 2007 results conference call. Here with us today are Mr. Tianqiao Chen, our Chairman and CEO; Mr. Jun Tang, our President; and Ms. Grace Wu, our newly appointed CFO.
Before we begin, I would also like to remind you that management comments during the call will contain forward-looking statements, that are based on our current expectations, and are intended to qualify for the Safe Harbor from liabilities for such statements established in the U.S. Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts during the conference call are forward-looking statements, which are subject to certain risks and uncertainties. Actual results may differ materially from those statements contained in the forward-looking statements. So, please do take a minute to read the safe harbor statements in the press release.
Now with that, I would like to turn the call over to our President, Mr. Jun Tang.
Jun Tang - President
Thank you, Maggie. Shanda delivered another excellent quarter in Q3 with record revenues and operating income. We posted a strong organic growth in all our online gaming business lines. Almost all our existing titles exhibited robust performance, while we are also delighted to see some initial revenues generated from Feng Yun Online, which we acquired in connection with our acquisition of Aurora Technology.
In Q3 2007, our consolidated net revenues rose 16.3% quarter-over-quarter and the 50.3% year-over-year to a record $87.4 million increasing [ph] on our earlier guidance of 8% to 11% sequential growth. Net revenues from our online gaming business also reached at historic high of $84. 4 million, up 16 points or 6% quarter-over-quarter and 54.9% year-over-year.
Not only did we see remarkable growth in our MMORPGs but also in all casual games. Net revenues from our MMORPGs increased 6.6% from the second quarter to $73.4 million with strong contribution from the various titles such as Mir II, Woool and LaTale, and an initial revenue contribution from the Feng Yun Online. We also released new expansion packs in third quarter for our main MMORPG including Woool, LaTale, Actoz [ph] Age, Feng Yun Online and Mir II.
During the summer holidays, we launched a series of in-game events and marketing campaigns for Shanda’s recent titles and upcoming new games. Shanda also made a strong presence at ChinaJoy, China’s most important nationwide event in online games and digital entertainment.
As a result, our MMORPG active paying accounts reached to 3.08 million, a 13.2% increase from the second quarter contributed by a higher conversion from players to paying customers for existing titles as well as new users from Feng Yun Online. We had the largest fee of our MMORPGs, ARPU rose 3.0% quarter-over-quarter to RMB59.7, considering our larger number of active paying accounts.
Turning to the casual games. All our casual games experienced a strong growth in this quarter. Casual game revenues in Q3 rose 16.2% quarter-over-quarter and a 6.9% year-over-year to $10.9 million supported by the seasonal strength and newly released expansion packs for Crazy Kart, Maple Story, Get Amped and Tales Runner during this quarter.
In July, we commercialized the Tales Runner, China’s first 3D running game which is the first of special sales of sports-themed game designed for the 2008 Beijing Olympics. Consequently, APA for casual games rose 8.4% quarter-over-quarter to 1.82 million, and the ARPU for casual games increased 7.2% sequentially to RMB10.0 in the third quarter.
Looking beyond on the third quarter we expect to see new expansion packs and value added service to support continued growth in our existing MMORPG titles, expansion packs for largest sports launch in Q4, including the renowned general for near two running passes [ph] for our winter expansions for LaTale where we will begin impacting of the highly anticipated Feng Yun Online, which we expect to be commercialized in early part of 2008. We also expect to launch World Hegemony, our first to web based game, developed by Shanda’s in-house R&D team. New casual games to be in world [ph] in Q4 including Pop King, Disney Magicboard Online, Superstar and a table tennis game, X-Up developed by Actoz. We are actively reviewing all pipelines for MMORPGs for 2008 and beyond. We are currently co-developing THQ Company’s Heroes and TECMO’s Dead or Alive, both of which we expect to launch in 2008.
We are also working with two content developers to introduce Gui Chui Deng Online and Creation of Gods. We expect both of these pilots to begin beta casting in 2008. We also recently licensed the highly anticipated AION: The Tower of Eternity from Korean developer, NCsoft, and it will be launched in later half of 2008.
On the casual games side we plan to commercialize several additional sports-themed casual games in advance of the summer Olympic games, including in-house developed and licensed games such as the free running game, the FreeJack from Wise On.
In summary, this has been a remarkable quarter for our online games business. Both our MMORPGs and casual games posted double digit growth. We are also saw an improvement of ARPU and active paying account number for MMORPGs and casual games. We believe our content portfolio and future pipeline will allow us to continue delivering rich content and fun and exciting games experience to our users.
Now I would like to turn the call to Grace Wu, our newly appointed CFO.
Grace Wu - Chief Financial Officer
Thank you, Jun. Good morning and good evening to all participants. This is Grace Wu. I will first start with highlights of our third quarter results followed by the outlook for the fourth quarter. In July 2007, Shanda successfully completed its acquisition of Chengdu Aurora Technology, a leading MMORPG developer and operator in China and increased its stake in Actoz Soft, a leading online game developer in South Korea to over 50%. As a result, Shanda’s financials beginning from third quarter 2007 onwards were exactly consolidated results of both Actoz and Aurora.
Now allow me to turn your attention to our results for Q3 ’07. In the third quarter first online revenues and operating income achieved historical highs to reach RMB656 million and RMB258 million respectively. I would like to point out that organic growth of our existing business was the main contributor behind this remarkable performance, as revenues for our newly acquired business represented less than 5% of our consolidated revenue for Q3.
Gross profit for the third quarter was RMB458 million or $61.0 million; that compared to RMB380 million in the previous quarter and RMB246 million in Q3 2006.
Gross margin was 69.8% in this quarter, compared to 67.2% for the preceding quarter and 56.2% for the third quarter 2006. This sequential improvement in gross margin was primarily due to the consolidation of Actoz, particularly savings on the company's licensing fees relating to Mir II. They are partially offset by the increased amortization expenses associated with IP amortization of Aurora and Actoz.
Income from operations for Q3 ‘07 was RMB258 million compared to RMB244 million in Q2 and RMB 130 million in Q3 2006. Operating expenses amounted to RNB200 million in Q3, ’07 that compared to RMB135 million in Q2, ’07 and RMB133 million in Q3. ’06. Increasing operating expenses were primarily driven by increased spending in sales and marketing related to a series of heightened campaign during summer holidays and China Joy.
Payroll adjustment effective as of June, which impacted the third quarter and the increased R&D and G&A expenses from the consolidation of Actoz and Aurora. As a result operating margin was 39.3% in Q3 compared to our earlier guidance of no less then 35%. Operating margin was 43.3% in Q2 ’07, and 25.8% in Q3 ’06.
Excluding the impact of our newly consolidated entities our gross margin and operating margin in Q3, ’07 will be 65.9% and 40.4% respectively.
Share based compensation remained flat quarter-over-quarter of $2 million in the third quarter of 2007. Our net non-operating income in third quarter will amount to RMB29 million which compared to RMB210 million in Q2 ’07. The main difference is the one-time gain of our RMB178 million from the sale of SINA shares which occurred in Q2 ’07 and the change in minority interest as a result of the Actoz consolidation. Non-operating income from government financial incentives in Q3 was RMB14.9 million. That compared to RMB14 million in the previous quarter and RMB29.1 million in the third quarter of 2006.
Net income for the third quarter of 2007 totaling RMB239 million remained relatively consistent to RMB238 million excluding the one-time gain from the sale of SINA shares in Q2. Compared to Q3 ’06, the net income rose 66.4%.
For the third quarter ’07 basic and [ph] diluted earnings per ADS were $0.44 and $0.44 respectively. This compares to adjusted EPS of $0.44 and $0.42 in Q2 ’07 and $0.26 and $0.26 in Q3 ’06. Effective tax rate was 16.4% in Q3 ’07, that compared with adjusted effective tax rate of 13.8% excluding the onetime capital gain impact from SINA shares sale, which is non-taxable. This increase of tax rate also included the impact of consolidation of the actuals. Excluding actuals impact, the effective tax rate would have been 16% in Q3 ’07.
For the first nine months ended September 30, 2007 consolidated net revenues totaled RMB1.75 billion, operating income amounted to RMB727 million while net income was RMB1.1 billion. U.S. GAAP and adjusted EPS per diluted ADS for the first nine months of ’07 was $2.02 and $1.24 respectively.
On the balance sheet side we would like to highlight a few items. As of September 30, our cash and cash equivalents balance of approximately RMB3.7 billion and RMB4.6 billion is including multiple securities and short-term investments. As a result of consolidation of actuals, investment in affiliate companies decreased to RMB3.7 million from RMB382 million as of Q2 ‘07. Deferred revenue as of September 30, increased 65.8% quarter-over-quarter to RMB417 million which is attributable to the high volume of prepaid card sales in anticipation of China’s national holiday in early October. On November 15, 2007 Shanda will redeem all of the remaining outstanding convertible notes which was approximately $275 million.
Before I turn to Q4 ’07 guidance we’d like to caution that we cannot predict the future exchange rate of RMB against the U.S. dollar, and therefore cannot actually, and with any degree of certainty estimate the effect of any change in exchange rates in our financial results. Accordingly, given our financial targets we assume no change in exchange rates in the fourth quarter of ’07, and have adopted the same exchange rate as of September 28, 2007, which in U.S. dollars is equal to RMB7.5108. Our actual results could differ however from our current expectations as a result of fluctuation in exchange rates.
Now, based on our business outlook, we expect our consolidated net revenues for the fourth quarter to increase 47% quarter-over-quarter, reflecting a relatively slower quarter tan Q3. In terms of margins, we expect our operating margin for the fourth quarter to remain at the similar level in the third quarter of 2007.
That concludes my presentation today. I would now like to turn the call to our CEO, Mr. Tianqiao Chen for his remarks to be followed by Q&A session. Thank you
